GUIDELINES FOR THE INDIVIDUAL TRUSTEES OF REVOCABLE LIVING TRUSTS
Now that you are a Trustee of a revocable living trust, you will want to manage it to maximum advantage. While this is not difficult to do, you should remember that a Trustee cannot always do everything that an individual can do, particularly after the death of a Settlor when a trust has become irrevocable.
This memorandum is intended to give you some general information and guidelines concerning the management of the trust during a trust’s three phases: (1) When both Settlors are living; (2) when only one of the Settlors is living and, finally; (3) when no Settlor is living. The memo covers such diverse areas as record keeping, tax returns, proper investment and management procedures, the duties and liabilities of Trustees, and allocation of assets (upon division into separate trusts). Because each trust document is different and each case has its own special facts, the general rules set forth will not always be applicable and this memo cannot substitute for specific advice on specific legal questions as they arise. Nor can this memo substitute for common sense and caution. Each Trustee must read and be familiar with the terms of the trust, and must carefully comply with those terms. If questions arise respecting the interpretation of the trust, record keeping, forms of title, whether or not a particular investment or sale can be made, etc., your attorney, accountant, or other advisor should be consulted. While the revocable living trust is a useful and flexible estate planning tool which, in many instances, can save substantial estate and income taxes, it demands careful administration if its tax and other benefits are to be achieved.
II. TITLE TO TRUST ASSETS
A. Transferring Assets to Your Trust.
It is important that title to all of your assets be owned by the Trustees of the Trust. Some of your assets have already been transferred to your trust. For example, you signed a deed transferring your residence to your trust at the same time you signed your trust. However, you must still transfer your remaining assets to the trust. Title to all of your bank accounts, stocks and bonds, real property, etc. must be transferred to your trust and held in the following form:
Malcolm Reynolds, Trustees of the
Reynolds Family Trust, dated September 20, 2002
If you acquire new assets in the future (i.e. purchase new real estate, open a new bank account or purchase new stocks or bonds), title to those new assets must be taken in the form set forth above. One of the documents that was prepared with your trust was a Certification of Trust. This document is designed to assist you in transferring property to your trust. You should show the original or a copy of that Certification of Trust to the person assisting you in the purchase of new assets (i.e. stock broker, real estate agent, new accounts bank officer), and it should explain any questions they may have about the trust you signed. IT IS VERY IMPORTANT THAT YOU TRANSFER TITLE OF YOUR ASSETS TO THE TRUST. ANY ASSETS NOT TRANSFERRED TO THE TRUST WILL NOT PASS UNDER THE TERMS OF THE TRUST AND MAY CAUSE A PROBATE PROCEEDING IN THE EVENT OF THE SETTLOR’S DEATH.
B. Perpetual Inventory of Trust Assets
Once you have transferred your assets to your trust, it is important that you keep an accurate record of the trust assets. To assist you in this process, we have enclosed an “Trust Inventory Form” which can be used to keep track of assets transferred to the trust and assets removed from the trust. The Trust Inventory Form should be updated periodically to assure that it accurately reflects all assets you have transferred to your trust.
III. MANAGEMENT DURING LIFE OF SETTLORS
A revocable living trust commences the moment the trust has been executed (signed) and funded. Complete funding of the trust is not necessary to establish it, but transfer of at least one asset to it is necessary. Different types of assets require different procedures to effectuate the transfer of title from the names of the Settlors; into the name of the Trustee, an the length of time necessary to transfer title to the name of the Trustee will vary depending upon the particular asset involve. Some assets not initially transferred into the trust may later be transferred into the trust even at or after the death of a Settlor. For example, the ownership rights in insurance on the life of a trustor (or another person) are usually not transferred to the trust, instead the proceeds are made payable by the beneficiary designation to the trust at the insured’s death. No matter when an asset is transferred into the trust, the Trustee must take care to properly collect the asset, have title registered in the name of the trust (i.e. the name of the Trustee), allocate the asset to the proper account and thereafter keep proper records of the transactions concerning that asset.
The benefits of a revocable living trust, such as avoidance of probate proceedings, accrue only to those assets held in the name of the trust by the Trustee. Therefore, it is important, as assets are sold and new assets purchased, that the Trustee handle all transactions as Trustee and be certain that new assets are registered in the Trustee’s name. The “closing” memorandum generally explains the manner in which assets are transferred into the trust. However, if types of assets are not covered by the closing memo acquired, or if there is any question as to proper registration, our office should be contacted.
B. Protecting Trust Assets
Once assets have been transferred to the trust, the trust agreement is fully operative as to those assets. So long as both Settlors are alive and competent, they may control the manner in which assets are invested and the manner in which the income and principal of the trust is distributed. The Settlors will have the control even if they are not Trustees. Thus, it is conceivable that the Trustee may have no significant responsibilities during the first phase of the trust, i.e. when both Settlors are living. Nevertheless, any assets which have been transferred to the trust and which should be covered by insurance, should also be protected by insurance while they are within the trust. If insurance is already in force, the insurance policy should be amended to add the Trustee as an insured party. This can usually be done at no cost.
Assets such as stocks and bonds should be placed in safekeeping, such as a separate safe deposit box. This safe deposit box should be used only for trust assets and should be held in the name of the trust by the Trustee. In this manner, bearer securities (such as municipal bonds) can always be identified as trust assets. Moreover, the death of a Trustee, even a sole Trustee, will not “freeze” the safe deposit box. The successor Trustee, upon presentation of a true copy of the trust, will be able to obtain access to the safe deposit box.
C. Actions of the Trustee
The Trustee is the legal owner of the trust assets. If there is more than one Trustee, the Trustees own the assets with survivorship rights similar to those of joint tenants. Property held in the name of multiple Trustees will pass to the surviving Trustees upon the death of a Trustee. If more than one Trustee is acting, the Trustees must act together unless the trust instrument expressly provides to the contrary. The Trustee is not the agent of the beneficiaries; the Trustee is the independent party who is responsible for his own actions. However, when both Settlors are living and directing the actions of another person acting as Trustee, this responsibility is only to the Settlors. A Trustee has no responsibility to persons who might take an interest in the trust in the future so long as both Settlors are living and the trust is revocable. As indicated below, once a trust becomes irrevocable, future beneficiaries may obtain enforceable rights and the Trustee then may act only after considering these rights.
When both Settlors are living, the Trustee should segregate the trust assets and keep trust records sufficient to allow the Settlors to prepare normal personal income tax returns.
D. Tax Returns
Tax returns during the first phase of the trust are treated exactly the same as prior to the execution of the trust. All income and expense items for income tax purposes are shown on the Settlors’ individual tax return. The trust is not considered a separate tax paying entity and does not file a separate tax return.
During the first phase of the trust, investment of trust assets is handled in the same manner as they would have been handled by the Settlors were there no trust in existence, except that trust transactions should be undertaken in the name of the trust by the Trustee and not in the name of the Settlors as individuals.
F. Taxpayer Identification Number
As the trust is not a separate entity apart from the Settlors during the first phase of the trust, the trust does not have a taxpayer identification number, provided the Settlor is the Trustee and the trust is still revocable, or if a husband and wife are Settlors, both spouses are Trustees, or one spouse is sole Trustee, or one spouse is a co-trustee with a third party. During this time period, the Settlor may furnish his social security account number to payors of income, and a payee must report income as if paid to the Settlor individually, not the trust.
IV. PROCEDURES ON DEATH OF A SETTLOR
When a Settlor dies, a portion of the living trust (usually consisting of all or part of the deceased Settlor’s separate property and his share of the community property) will usually become irrevocable. The duties of the Trustee then become more important and his responsibilities become substantially greater.
At the death of a Settlor, trust assets must be valued, death tax returns may have to be filed, assets must be allocated to the proper accounts or subtrusts, appropriate books and records must be established so that the income and principal receipts of each trust which has become irrevocable can be recorded accurately and investments must be more carefully made because the Trustee is now responsible to all of the trust’s beneficiaries, even if they are not yet born or identified.
Normally, the Trustee’s attorneys or accountants will prepare the federal estate and California tax returns where required by the death of a Settlor. They will also assist the Trustee in collecting assets, valuing them and allocating them between the various trusts. The attorneys will, upon request, assist with any questions of trust administration or interpretation. Most of these items relating to the continuing management of the trust are discussed in greater detail below.
V. MANAGEMENT DURING LIFETIME OF SURVIVING SETTLOR
A. Allocation of Assets
Upon the death of one of the spouse Settlors, the living trust is usually divided into two or three separate subtrusts, one called the Survivor’s Trust, one called the Credit Trust, and one called the Marital Trust. To the Survivor’s Trust is allocated one-half of the Settlors’ community property, all of the surviving Settlor’s separate property and, in some instances, a portion of the deceased Settlor’s separate property (marital deduction share). The balance of the trust property will be allocated to the Credit Trust.
Because federal law allows the Trustee to minimize taxes by valuing the decedent’s share of trust assets both at date of death and six months thereafter (unless they have distributed or sold) allocation of assets between the Credit Trust and Marital Trust and the Survivor’s Trust is not normally made until at least six months after the decedent Settlor’s death. Prior to allocation, the income, expenses and capital gains and losses are usually divided equally and allocated equally to the Survivor’s Trust, Credit Trust and Marital Trust. Once the Trustee has determined the extent and value of the assets which are held by the trust, the Trustee will allocate those assets between the Survivor’s, Credit, and Marital Trusts in the manner required by the trust document itself. Generally, most trust documents allow the Trustee to allocate various whole assets (rather than undivided interests) to each trust — to achieve better management, to encourage future estate planning, and to meet the varying needs of the different beneficiaries. For example, if the home and its contents are held by the trust it is quite common to allocate them to the Survivor’s Trust (rather than to the Survivor’s Trust and either the Credit or Marital Trust) so that the surviving spouse has not only their continued use, but the complete freedom to dispose of them as his or her needs dictate. It should be remembered that the Survivor’s Trust usually remains subject to revocation by the surviving spouse after the death of the first Settlor to die, or, if it is not revocable, is almost always subject to a general power of appointment (the power in the surviving spouse is to designate how the assets of the trust are to be distributed); thus property allocated to the Survivor’s Trust almost always remains subject to the control of and disposition by the surviving Settlor.
The actual allocation of the trust assets is usually accomplished by book entry in the accounting records of the trust rather than by actually registering title to the assets in the name of the specific subtrust (i.e., Survivor’s Credit or Martial Trusts). This allows the assets of the trust to be managed as a unit for purposes of economy. For example, if 60 shares of a certain stock are allocable to the Credit Trust and 40 shares of the same stock are allocable to the Survivor’s Trust, the actual certificate will probably be for 100 shares held in the name of John Jones, Trustee, of the Jones Family Trust. If it becomes appropriate to sell the shares held by one trust and retain the shares held by the other trust, this can always be done so long as accurate accounting records are kept.
The mathematical computations governing allocation of trust assets, while not difficult, are complex because of many factors which may be present. For example, while the property may be allocated to the Survivor’s, Credit and Marital Trust, death taxes, funeral expenses and expenses of last illness are usually chargeable only against the Credit Trust; debts (i.e. unpaid bills outstanding at time of the deceased Settlor’s death) may be chargeable to all trusts or in varying proportions to the trusts depending upon the nature of the debt and the amount of separate or community property available to satisfy the debt. Thus, it is most important when allocating trust assets for the Trustee to consult with attorneys or accountants skilled in fiduciary accounting (as opposed to business accounting) so that the all-important “starting figures” for each trust may be determined. The importance of proper asset allocation and generally getting off to a good start cannot be overemphasized.
B. Record Keeping
After the death of one of the spouse Settlors, the accounting records for the Survivor’s Trust are kept in the same fashion as the revocable living trust records were kept prior to the death of the spouse. However, the accounting records for the Credit and Marital Trust must, of necessity, be kept in greater detail and with greater accuracy. Because the Credit and Marital Trusts are a separate tax-paying entity and because the Trustee has responsibilities to both the income beneficiaries (usually the surviving spouse and sometimes other members of the family) and the remaindermen (those who will receive the property on termination of the trust), careful records must be kept of the transactions of the Credit and Marital Trust which has become irrevocable. These records must distinguish between income and principal receipts and income and principal. disbursements. For example, if the trust holds a note received on the sale of an asset and the note is being paid on an installment basis, each payment most likely will include both a repayment of the principal portion of the note and interest. These items must be broken down as each payment is received: The interest is allocated to the income account while the note repayment portion is allocated to the principal account. (This treatment may or may not be the same for income tax purposes as fiduciary accounting and fiduciary income taxation are not always parallel.) Similar careful treatment must be accorded expenses allocable to principal and expenses allocable to income. In some instances, the Trustee has the discretion to determine the manner of allocation as between principal and income or, in less frequent instances, the allocation is not clear. When any question of allocation arises the accountants or attorneys should be consulted.
Please note, again that fiduciary record keeping differs substantially from normal bookkeeping or even from corporate or personal income tax record keeping. A fiduciary is responsible for every penny which passes through his fingers and must therefore account to the penny. Thus, the Trustee is required to keep a precise record of every receipt and disbursement, every gain and loss, every distribution to a beneficiary, and every change in the nature of an asset of the trust. This is not difficult if good records are kept from the inception of the Trust. However, failure to keep good records will require time consuming and costly reconstruction of trust records for both tax and accounting purposes, and will raise adverse inferences against the Trustee should a dispute arise at a later date.
C. Tax Returns
As indicated above, the Credit and Marital Trusts are collectively a taxable entity. As such it is required to obtain its own taxpayer identification number, and is required to file its own tax return. Even if all of the income of the Credit and Marital Trusts are distributable to the surviving spouse, some “income” may still be taxable to the Credit Trust, and capital gains generated by sales or exchanges of assets held by the Credit or Marital Trusts are almost always taxable to that trust. Fiduciary income taxation is highly specialized field and most accountants are not familiar with its intricacies. Therefore, it is extremely important that an accountant familiar with fiduciary income taxation be employed to prepare the Trust income tax returns. Alternatives are to have the Law Office of Larry M. Nakahara prepare the returns or to have attorneys supervise the accountant in the preparation of the return. The Survivor’s Trust fiduciary income tax return is prepared in the same manner as the fiduciary income tax return for the revocable living trust was prepared when both of the Settlors were alive.
D. Taxpayer Identification Number
As the Credit and Marital trusts are separately taxable entities, a separate taxpayer identification number must be obtained. The identification number is required when a Settlor dies and any portion of the trust becomes irrevocable, or when a Settlor is not a Trustee or co-Trustee of the trust (as in the case of incapacity). The Trustee should obtain the services of an attorney or accountant to assist obtaining the identification number.
E. Powers of the Trustee
The powers of the Trustee are generally set forth in detail in the trust document. Depending upon the terms of the trust, the powers given the Trustee may be very restricted or almost unlimited. However, even where the Trustee is specifically granted absolute or sole discretion, the Trustee must always act in good faith, considering the interests of the income beneficiaries and the remaindermen. Unless specifically authorized otherwise by the trust, joint Trustees must act unanimously. Sometimes a Trustee may delegate powers to another Trustee or to an agent. However, a Trustee should be very cautious about the types of functions which are delegated to a person who is not a Trustee. For example, “ministerial” functions may be delegated, such as the trust accounting work or management of a business. Nevertheless, notwithstanding the delegation of the authority, the Trustee is responsible to oversee the delegated work and is responsible for the actions of the ministerial agent. Discretionary powers (for example, determining whether or not to distribute income and principal) may not be delegated. All decisions concerning trust distributions should be made by the Trustee. Decisions concerning trust investments should usually be made by the Trustee unless the trust expressly provides for the retention of separate investment counsel or vests the investment decisions in one particular Trustee. However, even then, the delegating Trustee probably has the responsibility to see that the delegated power is used prudently.
Generally, the Trustee has broad powers to sell, lease, borrow, pledge, and otherwise manage the assets of the trust in a businesslike fashion. If a question arises as to the existence or exercise of a power that is not clear from the terms of the trust, the attorneys should be contacted. In these cases where no ready answer is available (whether it concerns Trustee powers or other terms of the trust) a petition may be filed with the Probate Department of the Superior Court and the matter usually can be resolved within a short time.
F. Duties of the Trustee
1. Loyalty. The Trustee has an absolute duty of loyalty to the beneficiaries of the trust. This means that although the Trustee is the legal owner of the trust assets, all actions taken in connection with the administration of the trust must be with the sole interest of the beneficiaries in mind. Any self-dealing by the Trustee is breach of trust. The Trustee cannot deal in any way with the trust assets which would personally benefit the Trustee (as for example buying assets from the Trustee or selling assets to the trust) even if such action would be advantageous to the beneficiaries.
2. Impartiality. The Trustee has an obligation to deal with all beneficiaries of the trust impartially. In other words, a Trustee cannot favor one beneficiary over another or confer benefits to one beneficiary to the exclusion of others. It is especially important not to allow the personal feelings of the trustee towards a beneficiary to interfere with the Trustee’s impartiality in dealing with that beneficiary.
3. Avoid Conflict of Interest. The Trustee has a duty not to use or deal with trust property for the trustee’s own profit or for any other purpose unconnected with the trust, nor to take part in any transaction in which the Trustee has an interest adverse to the beneficiaries of the Trust. For example, the Trustee cannot make loans of trust money to himself or herself, and the Trustee is not allowed to purchase property from or sell property to the trust without obtaining permission of the Court having supervision over the trust.
4. No Commingling of Trust Assets. The Trustee has an obligation to keep trust funds separate from the Trustee’s personal funds. The Trustee must keep trust funds in separate trust bank accounts registered in the name of the trust, and only trust funds should be deposited to such trust bank accounts. The Trustee is forbidden from commingling the trustee’s personal funds with trust funds. For example, the Trustee should not deposit trust funds into the Trustee’s personal accounts “because it is more convenient” with the intention of eventually transferring those monies to the trust’s accounts at a later date. All trust assets must be registered in the name of the trustee as trustee of the trust and not in the trustee’s name alone. For example, “John Doe, Trustee of the Doe Family Trust, dated July 15, 1998″ is the proper designation for trust property. However, simply registering the trust assets as “John Doe” without the trustee designation is improper.
5. Investments. The Trustee has the responsibility for administering the trust in a manner most beneficial to the beneficiaries in accordance with the terms of the trust agreement. Normally, the Trustee will be given power to invest as would a “prudent man,” namely, to manage the trust funds with regard to their permanent disposition and considering both the probable income to be earned as well as the probable safety of the principal. Such a standard recognizes the Trustee’s duty not only to the income beneficiaries but also the remaindermen. Thus, for example, if the Trustee invests in a wasting asset, such as an oil royalty interest subject to depletion, a portion of the income received must usually be set aside as a reserve to replace the depleting principal; otherwise, the interests of the remaindermen would be prejudiced. Conversely, the Trustee may be required by the terms of the trust to establish no reserves or even to retain certain assets although they produce no income. Thus, you can see that paying close attention to the terms of the trust is of great importance. If there are questions the Trustee’s attorneys should be contacted without fail.
6. Record Keeping and Accounting. The Trustee is usually required to furnish the beneficiaries of a trust an annual accounting of his actions. This accounting shows the starting balance of the trust assets, adds the receipts and gains and deducts the distributions, loss and disbursements and then shows the remaining balance on hand at the end of the accounting period. The starting and closing balances will generally be at the “carrying value” for the trust which is most often their income tax basis. A good accounting will also show market values for the assets so that the investment decisions of the Trustee can be more accurately measured.
7. Summary. A Trustee must act with the highest good faith towards the beneficiaries and use ordinary care and diligence whether he is paid for his services or not. The Trustee may not deal with the trust property for his own profit, or for any purpose not connected with the trust. The Trustee may not obtain any advantage over a beneficiary or take part in any transaction with a beneficiary unless the beneficiary, with full knowledge of the transaction and having the legal capacity to enter into the transaction, specifically consents to the proposed action and permits the Trustee to do so. Similarly, the Trustee may not commingle his own property with the trust property; thus, separate accounts and accurate record keeping are an absolute necessity. A Trustee always has the duty of care. Unless the Trustee pays close attention to his “duty to be done” it is likely that his lot will not be “a happy one”
G. Trustee Liabilities
In many ways, a Trustee is an insurer. If the Trustee is negligent, he may be surcharged (i.e. fined) for his negligence. Thus, penalties and interest for failure to file tax returns will normally be borne personally by the Trustee. Moreover, the tax laws make a Trustee personally liable for unpaid death taxes to the extent of the assets held by him. Thus, most trusts allow the Trustee to withhold distribution of trust property until all death taxes are determined and paid so that the Trustee will not be later required to pay the taxes from his own personal funds. Failure to invest the trust property will subject the Trustee to liability for simple interest on the uninvested funds. If a court were to find that the Trustee wilfully failed to invest the trust property, he would be liable for compound interest and perhaps additional surcharge.
Trustees are entitled to reasonable compensation for the services performed to the trust. Trustee is entitled to compensation in the same manner as would anyone else performing similar management or investment services. This usually depends upon the time involved, the responsibilities undertaken, the results achieved and the magnitude of the problems encountered.
A good rule of thumb, generally used by corporate trustees in California, in estimating trustee’s fees is three-quarters of one percent of the principal balance of the trust per annum.
VI. MANAGEMENT OF TRUST AFTER DEATH OF BOTH SETTLORS
The discussion of the activities, duties and liabilities, set forth in Section IV, Management During Lifetime of Surviving Settlor, above, also applied to the management and distribution of assets after the death of both Settlors. Often the terms of the trust will then require specific allocation of certain assets to specified beneficiaries or trusts, as, for example, all of the stock in a family business to those children involved in the business; or will charge a beneficiary’s share with loans previously made to him or with prior gifts, etc. Obviously, the terms of the trust must be examined carefully to see that all of the Settlors’ directions are carried out.
If there are continuing trusts for children or grandchildren, these trusts may be separate trusts (i.e. separate tax entities each requiring its own tax returns) or separate shares (i.e. one trust with varying interests requiring only one tax return). Normally, the trust document will specify that separate trusts are to be used as they are usually most advantageous from an income tax standpoint.
If at any time trust income has been accumulated (i.e. not distributed but rather added to principal), the federal and California income tax laws require special computations resulting in additional taxes or refunds when the accumulated income is distributed. Those “throwback” rules are quite complex and accountants or attorneys should be consulted should there be questions regarding them.
The need to be familiar with and understand the terms of each trust cannot overemphasized.
VII. SUMMARY AND CONCLUSION
The revocable living trust is a flexible and useful device for managing property and, in many instances, saving death and income taxes. However, like a partnership or corporation, it must have adequate management and record keeping procedures. Once these procedures are properly established their continued maintenance is relatively easy. Most trust can be managed by individual Trustees, after they are successfully under way, with minimal assistance from accountants and attorneys, thus achieving numerous benefits for the Settlors, their children, and other beneficiaries, at minimal cost. Nevertheless, being a Trustee is a substantial responsibility and a Trustee should not hesitate to seek professional investment, accounting or legal assistance whenever questions arise. An ounce of prevention is worth a pound of cure.